A blur of change

by L. Joshua Sosland
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SAN FRANCISCO — How much has Diamond Foods changed in recent years?
A year shy of its centenary, Diamond was established in 1912 and operated for most of its 99 years as an agricultural cooperative by walnut growers. While the organization underwent a number of changes over the decades and increasingly focused on branded product rather than the marketing of an agricultural commodity, Diamond fundamentally remained a nut company well into the 2000s.

Even when the company completed an initial public offering in 2005 that changed the business from a cooperative to a Delaware corporation, Michael J. Mendes, chairman and chief executive officer, noted that walnut sales accounted for 65% of the company’s annual sales.

In the six years since, the company has diversified its business considerably from nuts, and when the Pringles brand is added (see sidebar) to the company, walnuts may account for less than 20% of total company sales.

Diversification was trumpeted by Diamond as a principal objective in its 2010 acquisition of Kettle Foods from a private equity firm and Pop Secret from General Mills, Inc.

“Kettle operates in the two largest potato chip markets in the world, the U.S. and the U.K., which increases the company’s addressable market by $9 billion,” Diamond said early last year.
Mr. Mendes said the addition of Kettle Foods, a potato chip and tortilla chip manufacturer, greatly strengthened Diamond’s presence in the snack market.

In the case of the Pringles announcement, benefits other than diversification were highlighted by Mr. Mendes.

To begin with, while acquisitions often burden the buyers with debt, the structure of the Pringles deal will help reduce the amount of debt Diamond carries as a percentage of its overall business, the company said.

“Diamond’s cash flow generation with the merger is expected to significantly improve and facilitate accelerated delivering of our balance sheet,” said Steve Neil, executive vice-president and chief administrative officer. “We anticipate a pro forma leverage ratio below 4 times EBITDA at the closing and dropping to below three times at the end of 2013.”

Mr. Neil participated in an April 5 conference call with investment analysts to discuss the transaction.
Also on the call, Mr. Mendes said Pringles has a number of unique strengths making it attractive to Diamond.

“The business has been built on a combination of proprietary products, unique package design and significant brand investments,” he said.
In the past decade alone, $2 billion was spent to build the Pringles brand, Mr. Mendes said, a sum equating to 85% of the price Diamond is paying for the business.

While Diamond intends to invest in building the Pringles brand, such continued spending made less sense for P.&G., Mr. Mendes suggested.

“As a practicality, Procter & Gamble is a great company, with gross margin structures north of 50%,” he said. “A business like this in their portfolio with a gross margin in the 30% range makes it very hard to see how they could afford to invest in the business. Say they can improve gross margin by 5 percentage points. It’s still going to be marginally dilutive to them.

“It was hard to see this being a part of the strategy in the context of the kind of company they are on the beauty care side, and this business works well for us. We are going into it looking to invest to make it more valuable. And how much it grows on the top line will be something we look forward to demonstrating in a lot more clarity after we close the transaction.”

During the conference call, Mr. Mendes was asked about integration challenges, and expressed optimism about prospects. He based that optimism, in part, on success with the company’s recent acquisitions.
“Our Kettle integration has been very, very successful,” he said. “I couldn’t be more proud of the team’s energy behind that effort, and we are today meaningfully complete on all of the major elements around the integration.”

While Pringles is a large company, much larger than Kettle or Pop Secret, Mr. Mendes noted that production largely is centered at two manufacturing facilities — one in Jackson, Tenn., and a second in Belgium.

“It’s really quite operationally streamlined,” he said.
From a markets perspective, Mr. Mendes repeatedly mentioned in the call that Pringles has a presence in 140 countries worldwide.

“When you deconstruct the brand positioning in the 60% of the world outside of the United States, it is definitely enjoying a premium positioning relative to other chips or potato crisps in those markets,” he said. “Pringles has strong brand awareness that exceeds 90% in key markets outside of the U.S. More than half of Pringles sales are in the U.S. and the U.K., which are also Diamond’s two largest markets, allowing us to effectively leverage our existing infrastructure.”

From the perspective of Procter & Gamble, the sale of Pringles marks the last chapter in a rich history in the food and beverage business. For decades, the company was a prominent player in the industry with brands that included Jif, Crisco (developed by P.&G. in 1911), Duncan Hines, Folgers and Pringles.
In P.&G.’s April 5 conference call, Jon Moeller, chief financial officer and vice-president, offered three reasons Diamond was selected as the buyer for the Pringles business. The structure of the transaction with P.&G. shareholders of much of the combined business, the decision was of heightened importance.

“One is they (Diamond) are a good company with a strong growth track record, and they offered a real opportunity to continue building this brand and a continued opportunity for growth for our employees,” Mr. Moeller said. “Number two, the value that they were willing to transfer was attractive. And three, their size made the construct of the Reverse Morris Trust transaction plausible. With a larger buyer, that wouldn’t have been possible. So those were the three primary characteristics of Diamond that I think make them an extremely attractive partner in this regard.”

Asked by an analyst about the timing of the Pringles deal, in fairly close proximity to Diamond’s takeover of Kettle, Mr. Mendes strongly hinted that Diamond was not the company that chose when to move.
“You don’t get to pick your time with good transactions,” he said. “Our merger and acquisitions calendar is not built on when is the optimal time and then buy the best thing that is available then.”

Even after the business combination, Diamond Foods will be a company modest in size, Mr. Mendes said. The company’s annual sales of about $2.4 billion would be larger than Snyder’s-Lance, Inc., at about $1.5 billion, but would be far smaller than Frito-Lay North America at $13.4 billion (a figure that does not include PepsiCo’s vast international snacks business).

“We are still, compared with the major consumer packaged goods companies, a relatively small company but a very focused company,” Mr. Mendes said.

Diamond Foods to acquire Pringles brand for $2.35 billion

SAN FRANCISCO — Diamond Foods Inc. has entered into an agreement with the Procter & Gamble Co. to acquire the Pringles brand for approximately $2.35 billion. The acquisition would more than triple the size of Diamond Foods’ snack business.

“Pringles is an iconic, billion dollar snack brand with significant global manufacturing and supply chain infrastructure,” said Michael J. Mendes, chairman, president and chief executive officer of Diamond Foods. “Our plan is to build upon the brand equity Pringles has established in over 140 countries. This strategic combination will create an independent, global leader in the snack industry with a focus on quality and innovative products. Not only is this combination immediately accretive, it also creates a platform that we believe will allow us to build shareholder value for years to come.”
According to Procter & Gamble, Pringles sales total about $1.5 billion annually. In its most recent fiscal year, Diamond net sales totaled $680 million.

The companies have agreed upon a Reverse Morris Trust transaction under which the Pringles business will be spun off in a tax-efficient transaction to Procter & Gamble shareholders who choose to participate. The business simultaneously will be merged with Diamond.

Elaborating on the $2.35 billion valuation, the transaction will include $1.5 billion in Diamond common stock, including 29.1 million shares for 57% of the outstanding shares of the combined company, and the assumption of an estimated $850 million of Pringles debt. Diamond shareholders would end up with 43% of the combined company.

The debt level assigned to the new company actually could range to as much as $1 billion or as little as $650 million, to be determined based on terms of a collar mechanism that would fluctuate the debt level based on Diamond’s stock price movements ahead of the transaction. Further details of the transaction will be announced in coming weeks, the companies said.

During the first year following the transaction, P.&G. will offer Diamond transition services. Diamond has predicted it will sustain costs of about $100 million associated with the transaction over the next two years.

Shares of Diamond Foods rose $3.84 per share in trading April 5 following the transaction, closing at $61.05, up 6.7% for the day. Following the market close, Diamond’s market capitalization equaled $1.34 billion.

Once the transaction, which is subject to Diamond shareholder approval, is completed, the combined business will be led by the executive management team and board of directors of Diamond Foods, led by Mr. Mendes. Headquarters of the company will remain in San Francisco. The companies expect the deal to be completed before the end of December.

Pringles have been sold since the late 1960s. Initially called a potato chip, Pringles are referred to as potato crisps because they are made with a blend of potatoes (dried potatoes are used for the dough), wheat starch and other ingredients.

The product’s saddle shape, stacked into a canister, differentiate Pringles from potato chips.
Pringles are offered in nearly a dozen varieties — sour cream and onion, cheddar cheese, barbecue, jalapeno, pizza, ranch, bacon ranch, loaded baked potato, salt and vinegar, honey mustard and original. The company also sells other Pringles brand lines, including reduced fat, multi-grain, extreme and Family Faves. The company also offers Pringles Stix bread sticks.

The addition of the Pringles brand expands Diamond Foods’ product portfolio, which also includes the Diamond of California, Emerald nuts, Pop Secret popcorn and the Kettle brand of potato chips.
Diamond Foods said the acquisition gives the company many advantages, including expanding its distribution infrastructure, gaining a broader global manufacturing and supply chain base in Asia, Latin America and Central Europe, and increasing Diamond’s geographic range. Pringles would grow Diamond’s international sales to 49% of total revenues on a pro forma basis.

For fiscal year 2012, Diamond Foods anticipates growth in its core business with earnings per share of $2.85 to $2.98 on a standalone basis, an increase of 15% to 20% from the midpoint of its fiscal 2011 guidance range, which represents a 30% increase over 2010 e.p.s.

“We are confident Diamond Foods will be an excellent new home for our snacks employees,” said Bob McDonald, chairman of the board, president and c.e.o. of Procter & Gamble. “This is also a terrific deal for our shareholders — maximizing value and minimizing earnings per share dilution.”


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